Federal Reserve set for December rate hike, Sterling takes a breather

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13 October 2016

Written by
Matthew Ryan

Senior Market Analyst at Ebury. Providing expert currency analysis so small and mid-sized businesses can effectively navigate international markets.

Sterling steadied itself around recent lows on Wednesday.

P
reviously, the Pound hit its weakest position against its basket of currencies since the Sterling trade-weighted index began in 1990 on Tuesday (Figure 1).

Figure 1: Sterling Trade-Weighted Index (2008 – 2016)

The Pound rebounded from its near 31 year low against the US Dollar during Asian trading yesterday after Prime Minister Theresa May claimed she would give lawmakers some scrutiny over the Brexit process. During Prime Minister’s Questions on Wednesday, May claimed she wanted ‘maximum possible access’ for the UK to the single market, alleviating some concerns that Britain is on course for a ‘hard Brexit’.

PM May’s conciliatory tone could be a sign that the UK government may take a slightly softer stance in Brexit negotiations going forward. This would undoubtedly support the Pound and could keep the currency contained in the current 1.20-1.25 range versus the US Dollar in the short term.

Last night’s Federal Reserve meeting minutes came in broadly as anticipated, with the FOMC adding precious new information. Policymakers saw the economic outlook as little changed, holding favourable views about private consumption and labour market developments. The case for a September hike was a ‘close call’ according to the committee, with the next hike to come ‘relatively soon’. Members George, Rosengren and Mester all voted in favour of an immediate hike at last month’s meeting.

We think the minutes reinforce the view that the Fed remains on course to hike rates again in December, with an outside chance of a hike in the first week of November. Financial markets seem to be in agreement and are now pricing more than a 70% chance that rates will be raised in the US before year-end.

We now await US retail sales figures tomorrow afternoon as the next major economic release. A number of senior Bank of England officials will also be speaking in Birmingham on Friday, including Governor Mark Carney.

Major currencies in detail:

GBP

The Pound’s seemingly relentless sell-off in the past few days took a breather on Wednesday, with the UK currency rebounded strongly during the Asian session before dipping by just 0.2% during London trading.

Comments from Theresa May about having a Parliamentary vote yesterday fuelled hope of a slightly ‘softer’ Brexit, although May’s stance on the need for full control over immigration could mean the UK is set for a long and protracted period of negotiation with Europe.

If Parliament puts up a good fight then Sterling will rally but, if PM May pushes back hard, the Pound is likely to fall.

Economic news continues to be completely overshadowed by political developments in the UK and we expect this to remain the case throughout the rest of the week.

EUR

The single currency dipped again versus a slightly stronger Dollar, trading just above the 1.10 level, its weakest position since the end of July.

Yesterday’s industrial production data beat expectations, dampening some concerns about an economic slowdown in the Eurozone. Production rose by 1.6% in the month of August, led by an impressive performance in Germany, with output increasing by 1.8% on a year previous, its largest expansion in four months.

ECB’s Coeure also claimed that he saw serious concerns over the sustainability of Greek debt, expressing hope that the IMF would soon get on board with some sort of relief for the country.

German inflation numbers this morning could give us a decent indication as to the strength of Monday’s more crucial Euro-wide inflation data.

USD

The Dollar was little moved following Wednesday evening’s FOMC minutes, ending the London session 0.3% higher.

Last nights Fed minutes suggested the next rate hike is close. Still low inflation, differing views on the level of slack in the labour market and concerns regarding global risks discouraged an immediate move at the September meeting. However, a ‘substantial majority of policymakers saw risks as roughly balanced’ and therefore voted to keep rates steady.

We think we are close to a tipping point where the majority will vote for a hike and expect more dissenters at the central bank’s next meeting early in November.

Federal Reserve member Harker will be speaking at 17:15 UK time. Investors will await Friday’s retail sales figures as the next major economic release in the US.

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